Government Shutdown Impact on Financial Due Diligence And Quality of Earnings
February 2026
The 2025 U.S. government shutdown, one of the longest in history, created significant operational and financial challenges for government contractors (GovCon) and defense sector participants. The lapse in appropriations resulted in delayed payments, halted contract awards, and widespread disruptions across the federal contracting ecosystem. These events placed additional pressure on mergers and acquisitions (M&A) transactions in the GovCon industry, heightening the scrutiny applied during the financial due diligence (FDD) and quality of earnings (QofE) process. Cash flow strains, unreimbursed costs, backlog uncertainty, workforce impacts, and compliance challenges all demand careful consideration.
This white paper examines the ways the 2025 shutdown influenced the FDD and QofE processes for GovCon targets. It also examines how our practice helps sellers present defensible, normalized financial positions that support strong valuations in challenging deal environments. As specialists in financial due diligence for GovCon and defense transactions, we provide targeted strategies to address shutdown-related volatility and position clients effectively in M&A negotiations.
Government shutdowns occur when Congress fails to enact timely appropriations, resulting in a lapse of federal funding authority. The 2025 shutdown affected non-essential federal operations, froze new contract awards and modifications, and delayed payments to contractors. In the GovCon and defense sectors, where federal contracts represent the primary revenue source, these disruptions created immediate and lingering financial and operational challenges. For M&A activity, shutdowns intensify the demands placed on financial due diligence. The 2025 event underscored the importance of identifying and adjusting for non-recurring impacts to avoid undervaluation of otherwise strong GovCon businesses. This paper explores the primary areas of impact and demonstrates how proactive FDD and QofE approaches enable sellers to navigate uncertainty and defend value in defense sector transactions.
Cash Flow Disruptions and NWC Normalization Challenges
The shutdown caused widespread payment delays to contractors, extending accounts receivable (AR) aging and straining working capital. This requires more detailed review of AR trends and unbilled receivables to assess liquidity risk. Normalization of net working capital (NWC) may involve excluding shutdown-related AR extensions, pegging targets to pre-shutdown historical averages. This approach enables sellers to demonstrate underlying liquidity strength, supporting more favorable transaction discussions.
At-Risk Work and EBITDA Add-Backs for Unreimbursed Costs
Many contractors continued performing "at-risk" work during the funding lapse, incurring unreimbursed expenses such as idle labor, overhead, and other carrying costs. FDD plays a critical role in quantifying these exposures. QofE strategies may include adding back these non-recurring costs to EBITDA, allowing sellers to present normalized earnings that more accurately reflect core operating performance. This strengthens the seller's position when defending earnings quality in negotiations.
Contract Award Delays and Backlog Valuation in Due Diligence
The shutdown resulted in minimal new awards or modifications, making contract backlogs less predictable. Deeper analysis of the pipeline and post-shutdown recovery potential should be considered. Revenue forecasts may be adjusted to normalize deferred or delayed awards, reducing the risk of valuation discounts. This enables GovCon sellers to present a more reliable view of future revenue visibility.
Furlough and Workforce Impacts on Operational Earnings Quality
Significant numbers of contractor personnel experienced furloughs, lost wages, or reduced productivity during the lapse. Adjustments for one-time costs such as severance or retraining helps sellers present a stabilized EBITDA profile that reflects normalized operations despite temporary workforce disruptions.
Small Business Contractor Vulnerabilities and Targeted Diligence
Smaller GovCon firms often experienced disproportionate effects due to limited cash reserves and greater sensitivity to payment and award delays. FDD places enhanced focus on size-specific risks. NWC adjustments to account for delayed small business set-asides enables sellers to present normalized financials that highlight underlying value.
Delayed Awards and Long-Term Contract Pipeline Effects
Delays in contract awards extended beyond the shutdown period, creating lingering effects on revenue visibility. Deeper scrutiny to pipeline diversification should be applied while preparing a QofE, mitigating buyer concerns over extended timelines.
Expense Recovery Mechanisms and QofE Add-Backs
Contractors pursuing reimbursement for shutdown-incurred expenses often face prolonged approval processes. The QofE process will help assess recovery claims, while including add-backs for unreimbursed costs such as overtime or acceleration expenses, enabling sellers to highlight potential future recoveries in normalized earnings.
The 2025 government shutdown highlighted the critical importance of sophisticated financial due diligence and Quality of Earnings analyses in the GovCon and defense sectors. By identifying, quantifying, and normalizing for shutdown-related impacts, sellers can present more accurate, defensible financial positions and better navigate M&A transactions in volatile environments. Our practice specializes in helping GovCon clients address these unique challenges, delivering tailored FDD and QofE strategies that protect and enhance value.
For More Information
Matt Volkmann, CPA
Phone: 703.344.7800
Email: [email protected]
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